Stamp Duty Land Tax - Shedding light on

The new SDLT calculations for leases require a methodical approach, says Peter Rayney.

Stamp Duty Land Tax applies to UK land and property transactions (post-30 November 2003), including the grant of a leasehold interest.

I reviewed the basic mechanics of the new SDLT regime in Accountancy, January 2004, p146. However, the SDLT computations for leases can be complex.

This article focuses on the detailed rules for calculating SDLT on the lease grants.

All statutory references are to the Finance Act 2003, unless stated otherwise.

Provided the land transaction is chargeable, SDLT is generally based on the amount of the chargeable consideration (s55(1)). This basic principle is followed for leases, but Sch 5 provides special rules for determining the 'relevant rental value'. (This is the net present value (NPV) of the rent payments due under the lease - see below). The SDLT rate applied to the value exceeding the relevant 'nil-rate' band is a flat 1%.

Where a premium is paid on the grant of the lease, this attracts an additional SDLT liability. This charge is computed separately under the normal SDLT regime (para 9(1)(4), Sch 5).

Lease definition

The SDLT legislation defines a 'lease' as:

•   an interest or right in or over land for a term of years (whether fixed or periodic), or

•   a tenancy at will or other interest or right in or over land terminable by notice at any time, para 1, Schedule 17A (as introduced by The Stamp Duty and Stamp Duty Land Tax (Variation of the Finance Act 2003)(No. 2) Regulations (SI 2003/2816)).

A lease does not include a 'licence to use or occupy land'. Such licences do not attract SDLT (s48(2)(b)). However, a licence only provides a 'non-exclusive' right of occupation, which does not give the occupier any legal protection. A legal document may be 'drawn-up' as a 'licence' but if it effectively grants an exclusive right of possession to the occupier, it will be treated as a lease (Street v Mountford HL [1985] 2 All ER 289).

Where a controlling shareholder personally owns property and makes it available to their company for its business, a licence could be used to avoid incurring SDLT. On the other hand, a licence is unlikely to be desirable for arm's length cases since the occupier requires security of tenure.

SDLT rates

When dealing with rents, different 'nil-rate' band thresholds apply, depending on the nature of the land comprised in the lease. Panel 1 shows the relevant SDLT rates for leases of residential property and property including a non-residential element. For rents only, the calculation follows the 'slice' system so that SDLT is only levied on the amount falling within the relevant band. Thus, if the relevant rental value exceeds the appropriate 'nil-rate' threshold, SDLT (at 1%) is charged only on the amount exceeding that threshold (ie, 60,000 or 150,000). Similarly, no liability arises if the 'relevant rental value' falls within the applicable 'nil-rate' threshold.

Before getting involved in detailed calculations, see whether the lease transaction is exempted under the disadvantaged area relief by doing a simple 'post-code' search on the Inland Revenue (Stamp Taxes) website.

Intra-group leases are exempted under the group relief provisions.

Compliance obligations

Section 77(2) provides that the grant of a lease is a 'notifiable' SDLT transaction where:

•   the lease period is at least seven years and is granted for chargeable consideration, or

•   for other leases, where the premium or rent attracts an SDLT charge of at least 1% (or would do so but for a specific relief).

In such cases, lessees must 'self-assess' and pay the appropriate SDLT and submit their SDLT 1 return form within 30 days of the 'effective date' of the transaction (this would normally be the date the lease is granted (s44)).

Net Present Value of rent

The 'relevant rental value' on the grant of a lease is calculated on a prescriptive basis (based on the rules in Sch 5). The basic principle is to find the NPV of the rental income stream over the term of the lease.

See Panel 2 for the legislative formula. To 'capture' the relevant rents, this formula requires the lease period to be identified and, in turn, the rental payments for each year.

The current temporal discount rate (T) applied is 3.5% (which may be altered by Treasury regulations). Each separate rent payment is discounted back to its present day value. (Any changes in rent after the first five years are ignored. This is covered by a special calculation (see below).) The total of these discounted rent payments gives the net present value (ie, the relevant rental value) for the lease transaction. A simple example with a four-year lease is shown in Panel 3. The Inland Revenue (Stamp Taxes) website provides a 'lease calculator' which automatically computes the SDLT on lease rentals.

In practice, property leases can be structured in a variety of ways.

The NPV calculation for fairly 'simple' leases with a specified rent for a fixed period should be relatively straightforward. Other lease agreements may be more difficult to interpret in terms of calculating the NPV of the rents. For example, a lease may contain a formula for calculating the rent (which may be based on the turnover of the lessee's business or increased annually in line with the retail prices index. It may also have 'break clauses', renewal options and so on. In such cases, special provisions are necessary to determine the amount of rental payments to be brought into the NPV calculation.

Fixed term leases

If it is possible for a lease to end before its fixed term (eg, under a 'break' or 'forfeiture' clause), this is disregarded in ascertaining the lease period. Such provisions cannot therefore be used as a device to shorten the lease period for the purposes of the NPV calculation. Any option to renew the lease is also ignored (para 2, Sch 17A). Thus, where a 10-year lease gives the lessee the option to extend the term for a further four years, it is still treated as a 10-year lease for working out the NPV of the lease rents.

However, some leases may continue beyond their original fixed term. For SDLT purposes, the NPV calculation is initially performed on the basis of the original fixed term. However, where the lease actually continues beyond its original 'fixed' term, the SDLT legislation treats it as a lease for its original fixed term plus one year. At this point, the lease grant may become notifiable on an SDLT return or a further SDLT return may be required. SDLT or additional SDLT may also be payable (based on the rates prevailing at the date the original lease was granted). These compliance obligations must be fulfilled within 30 days of the end of the original fixed term period (para 3(3), Sch 17A).

If the lease continues beyond the additional one year, a further SDLT re-computation takes place at that time with the same SDLT reporting requirements as before. This process is repeated for each additional year (para 3, Sch 17A). These rules do not apply to ('non-SDLT') leases in existence at 1 December 2003 (para 2, Sch 19).

Indefinite term leases

Some leases may be terminable only by notice or possibly for the life of the life tenant - these are known as indefinite leases. In such cases, the lease period is treated as an indefinite one for SDLT purposes (irrespective of any other statutory deeming provision).

Indefinite leases are initially treated as a lease for a fixed term of one year - with the NPV formula being applied to just one year's rent.

Where the lease continues beyond the first year, the lease is treated as fixed 'two year' lease. The NPV computation is reworked on this basis and an SDLT return/further SDLT return may be required. SDLT or additional SDLT may also be due (the rules are similar to those outlined for 'continuing' leases above). Again, if the lease continues beyond two years, this re-calculation process is repeated until the lease is determined (para 4, Sch 17A).

Fixed rent

Para 6, Sch 17A deals with the determination of the rent payable under the lease. Where the rent is fixed in amount, this can be easily be 'slotted' into the NPV calculation (as in the example in Panel 3). Where the lessee has made an 'option to tax' for VAT purposes, the rental figures used must include VAT.

Contingent/uncertain rent

Where the rent payable under the lease is wholly or partly contingent or uncertain, para 7, Sch 17A lays down the following procedure for working out the initial SDLT liability when the lease is granted.

•   The basic contingent consideration rules in s51 will apply so that any contingent rents are deemed to be payable.

•   Similarly, where any rent payment is uncertain or unascertainable (eg, because it is based on a formula, such as on a 'turnover-based' lease), then a best 'reasonable' estimate is made. There is one important exception to this rule where the lease provides for the rent to be adjusted in line with the RPI. In such cases, the potential RPI adjustments are ignored which means that the base (unadjusted) rent figure is taken.

•   Any (potential) changes in rent after the first five years are ignored.

However, para17(3) provides an important 'deeming' rule for the rent due after the initial five year period (for the remainder of the lease). This deems the annual rent due for that period to equate to the highest amount of rent payable in any consecutive 12-month period in the first five years of the lease.

Once the five-year point is reached, one further 'once-and-for-all' SDLT re-computation and SDLT return is made. The NPV calculation for this return will be based on

•   the actual rents for the first five years, and

•   the rent for the remainder of the lease. This is found by taking the actual highest rent paid over 12 months in the initial five-year period as the rent payable for each subsequent year of the lease (once again, ignoring any RPI linked adjustments) (para 7(3), Sch 17A). Special anti-avoidance rules apply where significant rent increases (as defined in para 14, Sch 17A) occur in this period - broadly, the rent increase is deemed to be the grant of a new lease.

If all the uncertainty relating to the rent is resolved before the end of the five-year period, then the additional return is made at that time.

Lease premiums

Where the tenant pays a lease premium on the grant of a lease, this is taxed separately under the normal SDLT rules albeit with some modifications (para 9(1)(4), Sch 5). Thus, the lease premium would be treated as 'chargeable consideration' and taxed at the relevant main rate (see Panel 4). In contrast to the SDLT 'rental' calculations, these are applied on the so-called 'slab system' (as shown in the example in Panel 5).

It is normally advisable to check whether 'disadvantaged area' relief applies, given its relatively wide application. Commercial (ie, non-residential) property situated in a 'disadvantaged area' is completely exempt from SDLT, regardless of the amount of the consideration. Residential property is only exempt where the sale consideration does not exceed 150,000.

Where a lease is granted for both a premium and an annual rent, a special anti-avoidance rule applies to prevent the respective values being manipulated to minimise SDLT. In such cases, where the relevant rental figure is more than 600 per year, the relevant 'nil-rate' band for taxing the lease premium does not apply. (For these purposes, the relevant rental figure is normally the average annual rent over the period of the lease, but see para 9(3), Sch 5). Where this special rule applies, the amount falling entirely within the 'nil-rate' band is taxed at 1% (para 9(2), Sch 5).

There are special rules for 'linked transactions' (para 9(2A), Sch 5).

•   Peter Rayney FCA, FTII, TEP is a tax partner with BDO Stoy Hayward's Birmingham Tax Consultancy Group, where he advises owner-managed companies and provides a consultancy service to accountants and lawyers. He is author of The Practical Corporate Tax Manual, published by CCH.

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